The Asian Financial Crisis and the emergence of RFA
The roots of the Asian Financial Crisis (AFC) of 1997/1998 are many: including a huge inflow of speculative foreign capital into Asia attracted by arbitrageopportunities and abetted by a pegged-exchange rate regime; misallocation of capital and financial mismanagement resulting from excessive liquidity; rapid deregulation and liberalization of the financial sector without stronger supervision; an explosion of corporate and financial borrowings that were short-term and denominated in foreign currencies.
The AFC was not the boom and bust of a normal business cycle, but one associated with speculative and erratic financial flows. Starved by low interest rates in developed countries, funds flowed into Asia searching for higher yields. Private capital flows into emerging markets reached S256 billion by 1997 compared to $42 billion in 1990 (Krugman, 2009a: 79)?
Figure 8.1 shows the massive influx of capital (the sum of net direct, portfolio and other investments) into three Southeast Asian countries before the Asian Financial Crisis of 1997 and the large outflows during the Asian and Global financial crises. Net financial flows into Thailand reached US$20 billion in 1996 and turned negative S10 billion in 1998, a swing of $30 billion. Similarly in Indonesia and Malaysia, the swings were too massive for the economies to absorb.
Drastic reversal of capital flows led to dramatic fall in currencies that ballooned foreign currency debt and bankrupted corporations and banks alike. The baht plunged from 25 baht to 50 baht per dollar and the rupiah from 2,500 to 15,000 per dollar at the height of the crisis in 1998. What began as a currency crisis in Thailand in July 1997 soon spread to other countries like Indonesia, Malaysia and even South Korea and spilled over to the real economy. Indonesia and Thailand were the hardest hit - banks and corporations collapsed, the economy shrank and unemployment soared — and suffered output loss of 40% of GDP. The fiscal costs of the crisis were estimated at 55% of GDP for Indonesia and 35% for Thailand (Caprio et al., 2003).
FIGURE 8.1 Net financial flows for three ASEAN countries, 1990—2013.
Sonne: ADB Key Indicators for Asia & Pacific (2010a, 2014a).
The response of international financial institutions and non-Asian countries to the AFC was timid at best and negative at worse. At the G7-IMF meeting in September 1997, Japan proposed to set up an Asian Monetary Fund to assist Asian countries suffering balance of payment difficulties to be funded by Asian countries of which Japan was willing to be the largest contributor. Both the United States and the IMF strongly opposed this Fund on the argument that it would encourage moral hazard. Most likely the reason was the U.S. did not want to set a precedent where regional cooperation or blocs could assert some degree of independence. Hence the Asian Monetary Fund never saw the light of the day (Masaki, 2007; Lipsey, 2003).
Instead, the IMF provided rescue packages to Thailand. Indonesia and South Korea and, as usual, imposed its one-size fits all solution and conditions on the crisis-affected countries even though the causes of the AFC were quite different from that of the Mexican financial crisis. Unlike Mexico, the Asian governments did not over borrow; it was mainly the private corporations and financial institutions that had crushing debt, many of which were short-term and in foreign currencies leading to a double mismatch in currency and maturity. The IMF imposed over 100 conditions on South Korea and Indonesia as part of its rescue packages many of which were only remotely related to the immediate causes of the crisis. What rescued the Korean economy was the rollover of short-term debt by foreign lenders. But the IMF took this golden opportunity to totally reform and restructure the Korean economy according to its neo-liberal framework.
In the case of Indonesia, the medicine given by IMF aggravated the economic ills of the country. The hike in interest rate to over 10% per annum did not stem the deluge of capital outflow (as evident in Figure 8.1); or the decimation of the rupiah that lost over 80% of its value; instead it smothered the economy as borrowers suffered crushing debt from high interest payment and ballooning principal repayment resulting from currency depreciation. It took over five years for Indonesia to recover. Malaysia also initially followed the IMF prescription but, within a few months, reversed course and implemented anti-cyclical as well as non-conventional monetary and fiscal policies that included capital control measures. These measures helped its economy to recover within two years without any assistance from the IMF.
Among the hard lessons Asian countries learned from the AFC was the need to pull up their own bootstraps; to lessen their dependence on the international financial institutions and Western countries; and to strengthen regional cooperation and resources to deal with financial crisis.
The failure of the existing international financial system to deal with AFC provided the impetus for Asian nations to search for an alternative RFA. J
The other impetus for greater regional financial and monetary cooperation is market considerations. While European economic and financial integration was driven more by political motives, Asian cooperation and integration is more market driven. Asian intra-regional trade and investment flows have risen over the years. Asian intra-regional trade was 54% of total trade in 2014; its intra-regional foreign direct investments accounted for 51% of total investments received in 2012. Asia’s intra-regional portfolio investments were less developed, making up only 15% of total portfolio assets and 20% of total portfolio liabilities in 2013 (ADB, 2014b: 43). The development of an Asian RFA would facilitate more trade and investments.
